This article is largely excerpted from David Leonhardt’s In Sour Home Market, Buying Often Beats Renting.
In much of the country, for much of the last decade, renting a home instead of buying would have saved you thousands of dollars a year. In many markets, today’s buyers are effectively betting that prices will rise enough to cover the difference.
Data from Moody’s Economy.com and real estate agents can’t foretell whether buying or renting is financially smarter. But the data can show whether a buyer will need a big jump in future prices to cover all the costs of owning—down payment, closing costs, property taxes, mortgage interest, repairs, and association fees.
A simple way to compare is to look at something called the rent ratio: the purchase price of a house divided by the annual cost of renting a similar one. (These ratios assume nominal property taxes.) The number 20 provides a useful rule of thumb: a ratio above 20 means you should at least consider renting, especially if you may move again in the next five years or so. When the ratio is well below 20, the case for buying becomes a lot stronger.*
In many large metropolitan areas, the average ratio is now 16 or lower. It was more than 25 in several of these places at the peak of the bubble, about five years ago. With a ratio as low as 16 and low interest rates, the costs of owning can be less than the costs of renting —and buyers will end up worse off only if prices fall considerably more. But ratios of 25 or 30 may indicate a bubble.
Owning a home brings benefits that are not strictly financial, such as stability and comfort. A family confident that it will stay put for a decade or more may be wise to buy today. Sometimes, however, the advantages of homeownership are exaggerated and renting does not get enough respect.
Business columnist Scott Burns offers three situations in which renting is probably better than owning:
- Young and mobile.
- If you are young and likely to change jobs and locations in the near future, owning a house doesn’t make sense, because the transaction costs for buying and selling are likely to wipe out any gains you might make from price appreciation.
- Older and short in both income and savings.
- Many couples celebrate their last tuition payment by buying a larger, more expensive house, reducing their ability to save and invest in the years when it is easiest. That’s the opposite of what they should be doing.
Others discover that their home equity is the bulk of their net worth. By downsizing or becoming renters, they can reduce their cost of shelter and have a more secure retirement.
- People who live in cities where owning costs much more than renting.
- Sometimes the cost of owning is wildly higher than the cost of renting comparable shelter.
Rather than indicate the better option for you or someone you know, this article may inspire some prayerful research.